On the Rise, on the Cheap

March 24, 2005

By Michael Kaye, CFA If a stock is in the midst of a winning streak, does that make it a good investment? Momentum investors think so. They buy stocks that have been strong recently in the belief that the factors pushing a stock upward will continue to propel it. Though the notion that stocks on a roll will continue to move higher is dismissed in some quarters, many investors follow this approach.

The idea is intriguing, and it gave us the starting point for this week's screen. We looked for companies whose price performance earned them an S&P 13-week

relative-strength ranking of 95 or greater, placing it in the top 5% of all stocks in the S&P universe. To make sure that these were companies of some substance, each name on the list had to have a

market cap above $1 billion.

FINDING 4s AND 5s. Strong momentum is all well and good, but we needed more. Specifically, we wanted to find those high-momentum stocks that had the potential to rise even higher. So we turned to another proprietary S&P tool: our

fair value rankings.

S&P's fair value -- the price at which a stock should trade at current market levels -- is based on fundamental data such as corporate earnings and growth potential, price-to-

book value,

return on equity, and current yield relative to the S&P 500-stock index.

An S&P fair value ranking of "5" indicates that a stock is significantly undervalued, while a ranking of "4" indicates stocks that are moderately undervalued, with a fair value modestly higher than the current price. We set our final filter to screen for stocks with those rankings.